I get confused with overvalued/undervalued based on CAPM and expected return and mess up on the easiest Qs. Which one is considered to be the intrinsic value - CAPM or expected return? does anyone have any suggestions? thanks!
CAPM is the Required (Intrinsic Value) Return. You compare your results from the CAPM with the Expected Return E®. If CAPM requires 10% and you are Expected to return 9%, the stock is overvalued and you do not buy. and vice versa.
These types of questions also come up in the form of asking “if a stock plots above the Security Market Line, is it _____”? The answer to this is undervalued. Using the example above, if the expected return is 9% and CAPM requires 10%, it means that for the level of risk (beta) you are taking on, you should be earning 10%, so 9% is not a good deal for that level of risk. If the E® were 15%, you’re earning more expected return than you should at that level of risk.
thank you guys! it helped a lot! I like thisisbrianly’s comment about the plot. I can grasp the concept better as soon as I picture the CAPM plot. thanks again!
IVC Wrote: ------------------------------------------------------- > thank you guys! it helped a lot! I like > thisisbrianly’s comment about the plot. I can > grasp the concept better as soon as I picture the > CAPM plot. thanks again! I think don’t get confused with CAPM plot. He clearly specified “SML”. Very important to note!
FYI: CAPM = SML
sgupta0827 Wrote: ------------------------------------------------------- > IVC Wrote: > -------------------------------------------------- > ----- > > thank you guys! it helped a lot! I like > > thisisbrianly’s comment about the plot. I can > > grasp the concept better as soon as I picture > the > > CAPM plot. thanks again! > > > I think don’t get confused with CAPM plot. He > clearly specified “SML”. Very important to note! I’m not sure what you mean, maybe I’m reading it wrong but he said SML and it’s the same as CAPM. CAPM is the equation of the SMLine.
I think you can ignore my comment. I said it because I have not studied anything called “CAPM plot”, at least Schweser doesn’t mention it. CAPM equation is definitely equation of SML, but I am not sure if plot is also applicable here.
the plot on the SML is just the position of your return on the SML curve which is derived from the CAPM
As my boss always says, you guys are in violent agreement…you both get it. By plot, I simply mean the SML…which is the same as a graphical plot of the CAPM equation with E® on y-axis and Beta on x-axis.